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According to the Center for Retirement Research at Boston College, in 2009, 51 percent of households were at risk of not having sufficient assets for retirement at age 65. As consumers face this risk at a time when traditional defined-benefit pensions are disappearing, and factors such as longevity and long-term care expenses are increasing, more and more people are turning to variable annuity (VA) products as a source of guaranteed lifetime income as part of their retirement strategy. In 2011, variable annuity sales were the strongest since 2007, according to Morningstar.

As interest in variable annuities continues to rise based on the income certainty they can bring to a portion of a client’s retirement plan, there is a broad movement across the industry to build risk-managed asset-allocation strategies into the products and their benefits. While the strategies do not ensure a profit or guarantee protection against a loss, they employ continual risk management and dynamic hedging techniques aimed at reducing a client’s exposure to extreme market swings so as to provide a more consistent pattern of returns. These strategies have emerged in response to the increased focus on preservation of capital–among both advisors and consumers.

Volatility is the new norm

Over the past decade, we have seen extreme market fluctuations with the S&P 500 declining by 43 percent from January 2001 to October 2002; more than doubling by October 2007, reaching its high of 1,565; only to decline by 57 percent to the bottom of the market in March 2009. In this world where volatility is the new norm, advisors need access to investment tools that allow them to manage the retirement assets and income of their clients through multiple market cycles.

Traditionally, in times of down markets, asset transfer strategies shift equities into fixed income options. However, this often results in the most significant recovery periods being missed, which can stunt portfolio growth. New approaches have now emerged, such as the use of institutional strategies with continual risk management, which are designed to help reduce the effect of equity market volatility on a portfolio and preserve capital during downswings. While there are no guarantees these that strategies will be successful, they are intended to keep clients invested in the market in order to capture upside potential. At a time when 8,000 baby boomers per day are turning 65¹, and facing a rapidly closing window of opportunity to maximize their retirement income, such risk-managed strategies allow advisors and their clients to focus on “time in the market” instead of “timing the market.”

These new built-in protected asset allocation strategies provide advisors and their clients the benefit of professional oversight on a daily basis. Historically, such volatility management approaches have been limited to the high-net-worth segment or institutional markets, but we are now seeing these protection strategies cascade into the retail environment for the average investor. This includes the younger generations where the majority of Generation Y and nearly half of Generation X are self-described “conservative investors².” By taking the best of asset allocation techniques and adding institutional risk management within variable annuities, insurance providers are making it easier for advisors to manage the daily capital risk for their clients and add value, while helping alleviate some of the fiduciary liability and risk that advisors take on with investment advice.

Advisors: Learn the Options

By designing volatility management into the annuity, insurers are also strengthening their own long-term sustainability, which is critical for advisors and consumers when considering that annuities can be 30- to 40-year investments. These investment strategies help insurers manage risk, reduce hedging costs and offer a competitive benefit and funds that remains relevant over the life of the contract regardless of economic conditions.

As these techniques to manage volatility and help protect capital continue to emerge and evolve, it’s critical to realize that these are sophisticated strategies and not mere funds changes. There are different approaches throughout the industry, and some insurance providers will even continue to offer the flexibility for clients to select their own assets within the annuity. Advisors should take the time to learn of the options available to them, understand how the protected strategies work and impact the client experience. Many providers in the industry are offering advisors in-depth training and education on the strategies to facilitate adoption.

The financial crisis has changed the way people evaluate and manage their retirement income. The traditional risk and return models of the Modern Portfolio Theory and the Efficient Frontier, which diversifies investments 60 percent/40 percent (equity/bond), proved ineffective in avoiding loss during the recent market cycles. To help clients avoid repeating history and further diversify, advisors are increasingly recommending annuities with guaranteed income as a retirement asset class. Since the 2008 market collapse, six out of 10 financial advisors classified as “sellers” of variable annuities have increased their VA recommendations³.

During this time, the design of VA products has evolved with the emergence of built-in volatility management and capital protection techniques. Some of these products provide the opportunity to remain invested in the market to capture upside potential and maximize retirement income, while providing downside protection. Success of these risk-managed strategies is not judged on a day-to-day basis, and it is true that there is the potential to achieve the same or greater returns by fully investing without the risk management, but the question to ask is, “Would I have remained in the market through the tech bubble or the 2008 financial crisis without it?”

Sources

  1. AARP.org
  2. Wall Street Journal, June 2011, Merrill Lynch Wealth Management Survey
  3. AllianceBerstein, 2011 “After the Crisis” Variable Annuity Survey

Disclosures

Lincoln Investment Advisors Corporation (LIAC) serves as the investment advisor to the LVIP Protected Profile Funds. LIAC is the subsidiary of The Lincoln National Life Insurance Company responsible for analyzing and reviewing the investment options within Lincoln variable products and providing recommendations regarding these options to Lincoln senior management.

Variable annuities are long-term investment products that offer access to leading investment managers, options for guaranteed growth and income (available for an additional charge), tax-efficient income options for after-tax money, tax-deferred growth, and death benefit protection for loved ones. An annuity’s value will fluctuate with the market, there are different types of costs associated with them, and all guarantees, including those of optional features, are backed by the claims-paying ability of the issuer.

Variable annuities are sold by prospectus. Investors are advised to consider the investment objectives, risks, and charges and expenses of the variable annuity and its underlying investment options carefully before investing. The applicable variable annuity prospectus contains this and other important information about the variable annuity and its underlying investment options. Read it carefully before investing or sending money. Products and features are subject to state availability.

There are no guarantees that asset allocation strategies will work.

Compliance Number: 201206-2068645

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